When you apply for a mortgage, the lender ideally wants to see you make a down payment of at least 20 percent of the purchase price. However, 20 percent isn’t a magic number, and the reality is that many borrowers put down less. In most cases with conventional loans, a down payment smaller than 20 percent will require some form of private mortgage insurance, or PMI. One of those options is lender-paid mortgage insurance, commonly known as LPMI.
What is LPMI?
LPMI, or lender-paid mortgage insurance, describes an arrangement where your mortgage lender covers the cost of your mortgage insurance.
While there are other options to pay for mortgage insurance — the most common is a monthly premium tacked onto your monthly mortgage payment — lender-paid mortgage insurance builds the cost of covering your insurance into the mortgage rate. In essence, you’ll pay a higher interest rate instead of a higher monthly mortgage payment.
How does LPMI work?
While you won’t see the charge for the insurance in your monthly mortgage payment, it’s still there with LPMI — you, as the borrower, are simply paying the cost in a different way.
To cover LPMI, a lender might charge you a higher interest rate to compensate for the higher risk of your lower down payment, or charge you a higher interest rate and buy a single-premium mortgage insurance policy on your behalf.
Either way, your interest rate and costs will be higher than they would be without LPMI, but you won’t be paying monthly mortgage insurance premiums, so your total payment might be cheaper. In some cases, it can be much cheaper.
How much does lender-paid PMI cost?
The cost of your LPMI will be expressed as an interest rate percentage, such as an additional 0.25 percent.
How high that percentage increase will be depends on a few factors, most importantly your credit score and the size of your down payment. As with all loans, the higher your score and down payment, the lower your costs will likely be.
For example, a lender might charge you an additional 0.25 percent if you can put 10 percent down. If you can only manage a 5 percent down payment, you’re a bigger risk, and your LPMI might be as much 0.5 percent higher.
Benefits of LPMI
There are two possible benefits to having your mortgage lender cover your mortgage insurance:
- The extra mortgage interest LPMI lenders charge is often less than a comparable monthly mortgage insurance premium.
- Your monthly payment might be more affordable, because the cost of the mortgage insurance is spread out over the entire loan term.
LPMI only makes sense if it costs you less than monthly PMI. You need to run the numbers (or have your loan officer do it for you) and then decide.
Disadvantages of LPMI
While there can be some upsides to LPMI, it’s important to understand the potential drawbacks, too:
- A higher rate that never goes down – LPMI involves a higher interest rate built into the loan. Unless you plan to refinance, that rate won’t ever drop, even after your balance falls below 80 percent.
- Potential for higher overall costs — Because you pay the higher interest rate for the life of the loan, your total costs could be higher with LPMI than with monthly borrower-paid PMI. It depends on how long you expect to hold the mortgage. If you think you’ll be in the home for a fraction of the loan (10 years and not 30, for example) LPMI might make sense.
- Tax implications — If you deduct mortgage interest when you do your taxes, LPMI isn’t broken out and thus can’t be itemized on your return; borrower-paid PMI, in contrast, can be deducted. However, since your interest rate is higher because of the LPMI, you’d stand to get a larger deduction if you itemize. Consult with a tax professional to maximize your ability to reduce your tax obligations, regardless of what kind of mortgage insurance you pay.
LPMI vs. PMI
As you weigh the pros and cons of LPMI, calculate the monthly principal and interest (P&I) with and without LPMI. For LPMI, a 0.25 percent rate increase is common when borrowers have excellent credit, but your actual rate depends on the lender you choose. Like all mortgage products, it pays to compare several offers when shopping for LPMI home loans.
Here’s how you might look at a PMI vs. LPMI loan on a 30-year fixed-rate mortgage for $300,000:
|Interest rate||Monthly payment (P&I)|
If the rate on the mortgage without LPMI is 4.5 percent, the monthly principal and interest would be $1,520. For a 4.75 percent LPMI loan, the payment would be $1,565, or $45 more per month.
Next, ask your lender for a monthly mortgage insurance quote. This quote will depend mainly on two factors: your credit rating and down payment. Consider these estimates from Freddie Mac for a range of monthly PMI premiums on a $300,000 30-year loan with a 4.5 percent interest rate:
- 15 percent down: $71
- 10 percent down: $176
- 5 percent down: $274
If you’re just considering the difference in monthly payment, LPMI clearly offers an advantage in this case, as you’ll pay only $45 more each month for your higher-rate mortgage. You’ll save money each month, and if you’re only putting 5 percent down, the difference is huge: $229 in every payment.
The monthly payment difference isn’t the only factor, however.
Once your loan-to-value (LTV) ratio drops below 80 percent, you can contact your mortgage lender or servicer and request to cancel borrower-paid mortgage insurance. For a $300,000 loan at 4.5 percent with an LTV ratio of 90 percent, the loan balance is scheduled to fall below 80 percent on the 74th payment, in just over six years. At that point, you can request cancellation.
Your payments aren’t the only way to hit that 20 percent equity marker when you’re paying mortgage insurance out of your own pocket. If home values are increasing in your area or you invest in a renovation that increases the home’s value, you might be able to get your property reappraised for the higher value and cancel your mortgage insurance earlier.
With LPMI, there’s no cancellation timetable — it’s simply part of the loan.
How to get rid of lender-paid mortgage insurance
There is no simple way to get rid of LPMI. You basically have two options: sell the home or refinance the mortgage. With a refinance in general, you’d need to ensure you get a lower rate and can afford the closing costs to make it financially worthwhile.
Alternatives to LPMI
There are many ways to buy a home with less than 20 percent down, and lender-paid mortgage insurance is just one of them.
- Consider a VA home loan if you’re eligible. VA mortgages for service members and eligible family members have no mortgage insurance. However, they do include a funding fee that functions pretty much the same way a single-premium mortgage insurance policy does.
- Jump on the piggyback. You might be able to avoid PMI and lower your monthly payment with what’s known as a piggy-back mortgage. This means if you put 10 percent down, you take out an 80 percent mortgage and a 10 percent second mortgage. This avoids PMI altogether, but it also comes with two mortgages that are both charging you interest.
- Pay it all upfront. There might be an option to pay single-premium mortgage insurance, which lumps your entire mortgage insurance coverage into one payment. This can save you money, but it means that you’ll need to hand over a large chunk of cash at closing (in addition to all the other closing costs you’ll need to pay).
Lender-paid mortgage insurance is not a simple concept. Here are a few tips to make your decision easier:
- If you are a first-time buyer, a lower monthly payment might make it easier for you to afford your home and qualify for your mortgage. You are also more likely to sell your home before your mortgage insurance would automatically terminate. So if LPMI gets you a significantly lower payment, that’s likely better for you than paying monthly PMI out of your own pocket.
- If you can afford a single-premium policy and you expect to own your home for enough years to surpass the break-even point, that is likely to be your cheapest option. This would also allow you to qualify for a loan more easily because your payment would be lower.
- If you expect to prepay your mortgage quickly, monthly PMI might be your best bet, because you can request cancellation when your LTV ratio hits 80 percent.
- VA home loan guarantees are benefits earned by service members, and VA mortgage rates are often the lowest available. There is no down payment requirement, and you can roll the funding fee into the mortgage. If you are eligible for a VA loan, consider this loan first.
- Other government-backed loans like FHA and USDA tend to have more expensive insurance costs. They require both an upfront premium (which you can finance) and a monthly premium that never terminates regardless of your loan balance. These loans have their advantages, but low mortgage insurance cost is not among them.
No one likes paying for mortgage insurance, but no one likes throwing money away on rent, either. So, if you’re determined to buy a home sooner, mortgage insurance can help you do that — and there are many ways to make the cost of the coverage more affordable.